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DreamWorks Not So Dreamy

Higher retail returns hurt guidance and sentiment.

What happens when a company sends out more product than retailers can sell? That product comes back, and earnings take a hit. For further reference, see DreamWorks Animation(NYSE:DWA) today.

Because of disappointing home-video sales of movies such as Shrek 2 and Shark Tale, DreamWorks saw a higher-than-expected level of returns, which in turn led to lower-than-expected results. Instead of a breakeven result for the quarter, the company is now looking for a loss of $0.07 to $0.09 per share.

Even worse for the company, this appears not to be a completely isolated problem. DreamWorks no longer seems to be expecting much of a contribution from Shrek 2 for the rest of the year, and annual guidance has been cut to a range of $0.80 to $0.90, versus the mean analyst estimate of $1.39.

Investors who follow this space might notice some parallels with rival Pixar's (NASDAQ:PIXR) recent issues with home sales of The Incredibles. There, too, lower sales led to higher returns and lower earnings for the quarter.

I'm not about to make excuses for either company, but this is a part of the business that investors need to understand and accept. It's very difficult to project the exact level of future home-video demand. And I think most people would agree that it's better to be a bit optimistic and put out too much product than to be too conservative and miss potential sales. As long as both companies continue to churn out popular and profitable movies, these issues should just be transitory.

That wasn't the only news for DreamWorks today, though. The company also announced that because of current market conditions, investors pulled their secondary offering. Investors including Jeffrey Katzenberg, David Geffen, and Paul Allen (through his Vulcan Ventures) had intended to sell as much as $500 million worth of shares. This offering wouldn't have diluted shareholders, but it would have represented a sizable chunk of stock coming to the market.

The good news -- such as it is -- is that three of the folks who know the company best don't want to sell at or near current prices. Of course, it's not as though any of these gentlemen are hurting for lunch money, so they don't really need to sell shares. Still, the fact that they think DreamWorks' shares are undervalued is a point in the stock's favor.

The company also announced an informal investigation by the Securities and Exchange Commission related to trading in the company's shares around the last earnings announcement.

So with the stock having dropped by 12% as of this writing, what should investors do? Well, I am by nature a contrarian, so when other people are running for their lives, I'm looking for opportunity. Of course, there's always that fine line between "savvy contrarian" and "stubborn lunatic."

I'm not all that put out by the SEC investigation, but I do think this is a challenging industry. Like the airline industry, the movie business seems to be dominated by outsized personalities and egos and not so much by sound, long-term business strategies.

Nevertheless, Pixar and DreamWorks Animation have both shown that they have a keen sense for developing products that are popular and family-friendly. With intelligent and well-heeled investors choosing to sit tight rather than bail out, I'm thinking that DreamWorks Animation might be getting close to that "cheap enough to take a chance" level.

We don't have flashy trailers, but we'd still encourage you to take a look at past features: